21 - Actuarial funding methods and valuations in the retirement context Flashcards
(21 cards)
What are the four main funding methods commonly used in defined benefit (DB) retirement funds?
The four main funding methods are:
* Attained age method (AAM)
* Entry age method (EAM)
* Projected unit method (PUM)
* Current unit method (CUM)
Define the standard contribution rate (StCR) and how the modified contribution rate (MCR) relates to it.
The standard contribution rate (StCR) is the target level of funding expressed as a percentage of payroll used to compare the funding methods.
The modified contribution rate (MCR) is defined as StCR plus variation arising from the assets not being equal to the AL (effectively the spreading of any surplus or deficit).
Explain the concept of “pace of funding” and its relationship to the overall cost of a benefit arrangement.
The pace of funding refers to the timing of meeting the cost rather than its long-term amount. Intuitively, earlier actuarial funding implies a lower opportunity cost of holding reserves and may reduce the overall cost to the sponsor in the long run due to investment returns. However, a faster pace might require higher initial contributions.
Describe the general aim of prospective funding methods like the entry age method (EAM) and the attained age method (AAM) concerning the standard contribution rate (StCR).
Prospective methods generally aim for a stable StCR over time.
Describe the general aim of accrued benefits methods like the projected unit method (PUM) and the current unit method (CUM) concerning the actuarial liability (AL).
Accrued benefits methods generally target the AL by funding for a target level of cover of benefits accrued to date.
Define the projected unit actuarial liability (PUAL).
The PUAL is the present value of all benefits accrued at the valuation date, based on projected final earnings for members in service.
Define the projected unit standard contribution rate (PUStCR).
The PUSTCR is the present value of all benefits of all members that will accrue in the control period by reference to service in that control period and projected final earnings.
Define the current unit actuarial liability (CUAL).
The current unit actuarial liability (CUAL) is the present value of all benefits accrued at the valuation date, based on current earnings for members in service.
Define the current unit standard contribution rate (CUStCR).
The current unit standard contribution rate (CUStCR) is the present value of all benefits that will accrue in the control period following the valuation date, by reference to service in that period and projected earnings at the end of that period, plus the present value of all benefits accrued at the valuation date (that is the start of the control period) in respect of members in service, multiplied by the projected percentage increase in earnings over the control period, all divided by the present value of all members’ earnings in that control period.
Define the attained age liability (AAL) and the attained age standard contribution rate (AAStCR).
The attained age liability (AAL) is the present value of all benefits that will accrue to current active members at the valuation date, by reference to service after that date and projected final earnings.
The attained age standard contribution rate (AAStCR), expressed as a percentage of earnings, is the present value of all benefits that will accrue to current active members after the valuation date, by reference to service after that date and projected final earnings, divided by the present value of total projected earnings for all current active members throughout their expected future membership.
Define the entry age actuarial liability (EAAL) and the entry age standard contribution rate (EAStCR).
The entry age actuarial liability (EAAL) is the present value of total benefits, based on projected earnings at retirement date for members in service, minus the present value of future standard contributions calculated from the assumed entry age.
The entry age standard contribution rate (EAStCR), expressed as a percentage of earnings, is the level annual percentage of salary from entry age required to fund the total projected benefits at retirement.
Explain how the entry age standard contribution rate (EAStCR) for a new entrant is typically calculated in a DB fund targeting an income replacement ratio.
For a typical new entrant, the EAStCR is often calculated to provide a fund at retirement equal to the present value of the benefits then payable. The calculation is similar to the AStCR but is performed at the assumed entry age of the member, considering their projected salary growth over their working lifetime.
What is the relationship between the accrued liability (AL) and the standard contribution rate (StCR)?
In practice, the actual asset level of the fund is rarely equal to the AL. The modified contribution rate (MCR) reflects this difference by adjusting the StCR for any surplus or deficit (MCR = StCR plus variation).
The definition of AL (which covers the benefits earned to date) and StCR (which aims to cover the cost of future benefit accruals) are intertwined in how a funding method operates.
Discuss the stability of the standard contribution rate (StCR) under the projected unit method (PUM) as a fund matures.
Under the PUM, the StCR tends to increase as the fund matures. This is because the cost of accrual increases with age, and as the average age of the membership increases, so does the overall contribution rate required to fund the accruing benefits.
Discuss the stability of the standard contribution rate (StCR) under the entry age method (EAM) as a fund matures.
Under the EAM, the StCR is designed to be relatively stable as a percentage of payroll over the working lifetime of the members. This method aims to spread the cost of benefits evenly from the assumed entry age to retirement.
How does the treatment of past service differ between prospective funding methods (like AAM and EAM) and accrued benefits methods (like PUM and CUM)?
Prospective methods like AAM and EAM implicitly deal with past service by calculating a contribution rate needed to fund all future benefits from the valuation date (AAM) or the entry age (EAM). Accrued benefits methods like PUM and CUM directly calculate a liability for benefits considered earned up to the valuation date based on service to that point.
What are some key considerations when choosing an actuarial funding method?
Key considerations include the security of benefits, the stability of contribution rates, the realism of the method in reflecting the underlying benefit promise, accounting requirements and the impact on financial statements, and the flexibility the method offers to manage funding levels.
Explain the concept of a “closed fund” and its typical impact on the standard contribution rate (StCR) under different funding methods.
A closed fund is one where new members are no longer admitted. In a closed fund, the average age of the membership will tend to increase over time. Generally, the AASStCR and PUStCR will increase as the membership ages and tends towards retirement, while the EAStCR will remain relatively stable as it is based on an entry age assumption that doesn’t change. The CUStCR’s behavior depends on the specifics of the benefit design and salary progression.
Describe the purpose of having “Contingency Reserves for DC funds.”
In a DC fund, Contingency Reserves are established out of contributions paid into the fund and any investment return on those contributions. They are intended to provide the fund with the ability to meet larger-than-expected expenses or operational irregularities and protect the fund against unforeseen events or risks.
What is a “Risk Reserve” in the context of retirement funds?
A Risk Reserve is a reserve established to cover benefits providing protection against death and disability, in addition to retirement benefits. These reserves are actuarially determined and reviewed on an ongoing basis to ensure sufficient funds are available to meet potential claims.
Explain the role of an “Investment Reserve” in a retirement fund.
An Investment Reserve can be built up in years when investment performance is strong to smooth the impact of future periods of poor investment returns. This reserve helps to provide more stable returns for members and can be used to buffer the fund against market volatility and potential funding deficits.
